Promoting private sector development in Tanzania: Don’t ask the firms what they want!

If you are raising your children by focusing on giving them what they want, don’t read this blog. Today most governments want to help the firms operating in their country. But because this task is a complex one, their strategy has been to ask businessmen directly.

In Tanzania, almost every week, there is a new survey reporting firms’ concerns or wishes. If this has proved useful to understand better the entrepreneurs' motivation, in my view it may have led to some misguided policy actions, at least in the formulation of priorities, by the authorities.

Allow me to illustrate. According to the entrepreneurs operating In Tanzania, electricity is their major constraint (85 per cent) followed by access to finance (52 per cent), taxes (37 per cent), and administrative red tape (25 per cent). Source: World Bank. Investment Climate Assessment, 2009. Surprisingly, labor and transports costs are only at the bottom of their concerns (less than 10 per cent). According to this ranking, the priority should be therefore given to reducing electricity costs, increasing access to finance and reducing taxation.

A closer look at the firms’ financial balance sheets provides a different picture. In reality, electricity counts for a marginal share of firms’ operating costs in Tanzania (see Figure). For example, it is equivalent to only 3 per cent for a standard firm operating in the apparel sector. In other words, a decline, say, of 50 per cent in electricity prices would only reduce its costs by 1.5 per cent - hardly a high number for such a big effort. By contrast, transport and labor costs are equivalent to 41 per cent and 38 per cent of its total operating costs. This means that reducing transport costs by only 4 per cent would achieve the same gains for the enterprise than cutting by half its energy costs.

Operating Costs of Tanzanian firms

Source: MIGA, Cost Benchmarking

This example should be qualified. Not all enterprises have access to electricity and so improved access can make a difference. It also matters for energy intensive activities such as mining and cement. However, excessive emphasis on energy will hardly reduce the operating costs of most existing firms in Tanzania, principally for those that are expected to create jobs in manufacturing and services. By contrast, an improvement in transport or labor costs will do it. If the goal is to achieve rapid and visible gains in competitiveness, the Tanzanian authorities should clearly focus on transport and labor (through improved productivity and skills).

The confusion between perceived and real constraints faced by firms has been visible in development strategies adopted by the Tanzanian Government. It has also been conveyed by development partners who conducted these surveys. Both sides have been making too much from perceptions. Policymaking is about defining priorities right. While all efforts to reduce production costs are welcome, not all of them will make a significant difference. Public resources are also limited, imposing trade-offs between reducing taxes and building power plants or roads.

The current choices have been made on the basis of what entrepreneurs want but not necessarily on what they need. If I was teaching my children by focusing exclusively on their wishes, it would certainly make them happier but it will hardly prepare them for real life. It is time for a reality check – reducing transport costs and improving labor is what really matters for improved competitiveness in Tanzania.

Comments

Very interesting and thought provoking blog!
But I am not convinced the evidence presented is strong enough to lead to the conclusion that there is a mismatch between what the firms want and the real priorities of Tanzania. Your conclusion is largely based on the cost of electricity, although you made an attempt to qualify it by bringing in the issue of access. I think that the qualification should go further than mere access. The firms may have access, that access itself may need to be qualified. Do they have access without the notorious interruptions common in most African countries? Do they have electricity at the level and timing desired for smooth operation of their business? The surveys you referred to may have collected more information that may have answers to these questions and shed more light on why the firms consider electricity to be their number one constraint. Moroever, firms' concerns about electricity may go beyond their immediate premises, as they often rely on suppliers, distributors, consumers and so on, who may not have adequate access to electricity.
So in my opinion, it is better to look beyond cost and "access" before reaching at such sweeping conclusion.

Good to see someone saying this. A related point is that existing companies are to some extent, those that are well adapted to the local constraints such as a labour force with lower skills. The companies for which these constraints are a serious problem may have already gone out of business! Taking a slightly longer term and more dynamic view means looking beyond what current firms want and thinking about what different types of industry could grow if those constraints were lifted... But perhaps that sounds too much like old-fashioned industrial planning for modern governments to want to engage in it?

While I agree that transportation should be a priority, this is a fairly limited analysis of the problem. The issue at stake is not the price of electricity but its reliability. Tanzania has been plagued by blackouts and brownouts, all of which effectively multiply the losses from sunk costs. With a parastatal such as TANESCO, the premise that the price of electricity per kilowatt-hour reflects the true cost of Tanzania's energy sector is flawed. Perhaps a better measure would include the down-time that plagues Tanzania's grid.
For example, electricity may only account for 3% of costs to horticulture sector firms, but it is a key component of the production process that allows the packaging of products. When there is a blackout for a few hours, horticulture firms presumably still pay their workers. Next, fewer products are able to be shipped and many more expire because they weren't able to be packaged quickly. This reduces the profit from each trip to market. Ultimately, unreliable utilities cost a firm far more than 3% of its expenses.
Of course, one could argue that labor, land, and transport are all integral parts of the production process without which a firm could never succeed. However, it appears that few involve as much uncertainty as electricity. Transportation has been a major issue for decades, and firms are ultimately able to predict and compensate for how much profit is lost during transport. To an extent, these losses are controllable. Major delays to an order because the entire factory is shut down can damage inputs as well as the credibility of a firm.

This is an interesting and useful topic, but I see two main issues in this posting:
First, I would question the notion that business owners should be equated with children, or that government bureaucrats (or World Bank bureaucrats for that matter) are superior in assessing what should be the priorities for reforms to improve the investment climate. Of course, investor's opinions should never be considered the "last word" on the subject - they will always ask for lower taxes no matter how low they are already; but it's hard to imagine that their opinions should not be considered at all.
Second, it is important to avoid confusing a poor questionnaire design with a whole methodology. If a questionnaire offers only a list of a dozen or two potential "problems" and fails to address the concerns of businesspeople in a particular country at a particular point in time, the survey respondents are likely to gravitate toward whatever response seems closest to their real concerns. Thus frustration over electricity outages might get picked up by anything on the list that mentions electricity. This doesn't mean you shouldn't survey business people; rather it suggests that the questionnaire should be improved (in this case, more tailored to the circumstances and less "generic").

Morisset did not equate business owners with children, you did, by applying literal meaning to what was obviously a figure of speech. Your English 1 instructor would be appalled.
The takeaway from Morisset's note is "Pay more attention to what firms say they need in response to a questionnaire that they perhaps pay little attention to.
Nothing more, you cannot win a PhD degree for "analyzing" that.

In development, there has always a been tension between the " expert knows better " and " ask the people themselves what they need".
This article puts everything very much in perspective. Crowd-sourcing needs is not a sufficient alternative for a good analysis. In a good analysis, the opinion of the beneficiaries must be a very important element.
Worse is it of course, when entrepreneurs from the North or ministers form the North decide what the entreprises or people in the South want.
The programs of donors risk to take this route.

Jacques: Surely you don't mean to suggest that reform priorities should be based on the average cost composition of production? (I don't pay much ady-to-day for water, but I very much depend on a reliable supply.) Shouldn't we be comparing and looking for excessive costs that can be addressed through policy reforms or other public interventions, as well as those factors that may be associated with lower productivity than relevant comparators? With regard to electricity, the 2009 ICA was quite clear that the timing of the survey influenced the high perceptual priority placed on that factor: "The timing of the survey probably contributed to the firm managers‘ extremely high concern about power supply. Although the poor performance of the power sector has been a problem in Tanzania for many years, the Enterprise Survey took place during a serious power crisis that hit the country in 2006. Growing demand and a steep drop in hydroelectric generation capacity led to load shedding (i.e., rolling, intentional power outages) and almost daily outages for many firms throughout the country." [Tanzania ICA 2009]. The perceptions point to a problem, but the explanation of that perception may or may not lead to public interventions depending on supplementary analysis. Survey findings by themselves are not enough to go on, but can provide some useful quantitative as well as perceptual indicators on multiple issues, as can other indicators. The important thing is not to reify the data on constraint rankings, but to use each data source intelligently and to draw from multiple sources.

While I agree that one cannot take just entrepreneurs' responses only as indicator of importance of an issue for development (for example, entrepreneurs are not good at all at identifying their own skills as an issue), I think in Tanzania the issue is reliability, not cost of electricity:
The enterprise surveys also show that Tanzanian enterprises suffer on average of over 9 outages in a typical month and lose an average of over 7% of their annual sales (vs. the already high 5.1% in SSA, and 3% in all developing countries) due to outages.
Therefore, almost half the enterprises have to have a generator - which, particularly for smaller enterprises constitutes a huge cost. For the forthcoming IFC jobs study - about to be launched on January 14th/15th - we estimated that for a small enterprise the cost of electricity may be over 200% higher if they have to get power through a generator.
Incidentally, we also estimated that in the countries most affected by power outages - like Tanzania - the job growth was significantly higher than in companies that had a generator. Given how expensive electrity from generators is, one can only imagine how much higher job growth would be with reliable power from the grid.
If you are interested in findings like these, please come to the launch of IFC's jobs study ...
Roland

This is the wrong analysis. You can't just equate "cost" with "importance", which is effectively what this is suggesting.
Electricity may be a low part of firms' overall cost and may still be (is) of paramount importance. Without electricity, much of the other labor and capital is useless. The goal is not saving costs. The goal is productivity.
Also, kids on Christmas are not the same as largely-rational, externally-accountable organizations of educated and experienced executives.
I think the idea that we shouldn't listen to the people who are on the ground developing industry when they talk about their difficulties is...well, dangerous.
Didn't we just get past realizing we should actually talk to beneficiaries when distributing aid? So why don't we do that when we are helping businesses? Are we really ostentatious enough that we think we know better...again?

My provocative blog is getting quite a few reactions that are also quite provocative. This is good. Just want to clarify that electricity, and access to it, is crucial for firms. Without electricity, there would be no industrial and service activities. But many of us (advisers,consultants, policymakers....not firms) tend to forget that skills and transports do matter a lot, and frequently more than electricity. Many firms do not invest in Tanzania because unit labor costs are relatively high (low labor productivity with relatively high nominal wages --see recent excellent paper by A. Geld and Vijay) and transport costs are excessive (the Dar es Salaam port is one the least efficient in the world and domestic transport is still a nightmare with poor infrastructure and many roadblacks. See recent Trademark studies for more evidence.

Jacques: You cite Alan Gelb and Vijaya Ramachanran (and Benn Eifert), but their work relies heavily on the data generated by business surveys. You chose to focus on only one aspect of business surveys, the perception question, which comprises a minority of the standard enterprise survey questions used by the World Bank in its investment climate work. The productivity calculations and the association of various factors with firm-level performance depends almost entirely on survey data. A better title for your blog would have been: "Ask firms what they want, but ask them other things, too!" See, for example, "Business Environment and Comparative Advantage in Africa: Evidence from the Investment Climate Data by Benn Eifert, Alan Gelb and Vijaya Ramachandran; Center for Global Development Working Paper No. 56 http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID997383_code794896.pdf?abstractid=997383&mirid=1; Generally, surveys generate a wealth of factual information on costs (dollars and days) and performance, shedding light on such issues as worker education and training, regulation and corruption, and infrastructure (including transport!). Incidentally, another article by Gelb and Ramachandran to which you may be responding is "What matters to African firms? the relevance of perceptions data" (World Bank, 2007)

I recently visited a large manufacturing company in Dar. It has a 10 MW machine which stretches sheet iron. When the power shuts down at the wrong time, the iron roll breaks and in bad cases it whiplashes into the compression rollers. The manager showed us 3 damaged rollers each costing $500,000 to replace. Electricity is such a problem that the firm is planning to build its own power station once the gas line is built to Dar.
I do think it is important to listen to businesses. Of course, they may use the opportunity just to lobby for reduced costs or higher sales, but they may also be correctly identifying real symptoms. The main problem with business surveys is that firms often don’t diagnose the problem correctly. It may well be true that electricity supply and quality are a problem in Tanzania but this may be caused not by a lack of investment or technical skills in the power sector but by the political economy of electricity supply. The next question to ask is “what are the incentives in the power sector?”, “who set those incentives?” and “what would it take to change them?”. If a single company is planning to invest in a dedicated power station that points to the possibility of a private-sector run industrial power grid: yet my guess is that this would be impossible under the current regulatory regime.

Agree with Nemo, he is totally right and I think that you guys should not be patronizing the whole system into what it is not? How do you want us to learn about this stuff on our own? That’s the question.